Selling A Business – How Much Is My Company Worth?

By Generational Equity

01/28/2013

This is the second article in a series examining common questions from attendees at our M&A seminars. A couple of days ago, we focused on the question of timing, i.e., selling a business when it is the optimal time to do so. Today we look at a second question we get quite often, which is: What is my business really worth?

Of course when a seminar attendee asks our professionals this question, we have to say that we have no idea at that point. This frustrates many business owners who are hoping to have an idea right away of what we think the business is worth.

But until we complete a thorough evaluation of the company, we literally have no idea what the value of the business is, and any attempt to provide an answer to that question in our initial meetings would be considered “ballparking,” which professionally is a big no-no.

The first step in an engagement with any legitimate M&A advisory firm like Generational Equity is the evaluation phase. It is during this critical step that the “economic” value of your business is determined. This valuation is based purely on recast financials.

If you are not familiar with recasting, it is the accepted accounting principle that eliminates from the historical financials any items that are unrelated to the ongoing business operation. These can include superfluous, excessive, or discretionary expenses and/or non-recurring revenue and expenses.

Recasting is vital because it provides an “economic” view of the company as though it were run by management dedicated to maximizing profitability. Some common examples of these recast items would be surplus company cars, discretionary business trips that double as vacations, other write-offs such as luxury box seats at sporting events, leased boats or planes – essentially anything that has been used legally to reduce taxes. Let’s face it, you have probably been working with your tax accountant for years to do so. Recasting recaptures all of that and shows the true profitability of your company.

Once recasting is complete (and be prepared to spend several hours if not days working with both your accountant and your M&A advisor on this), it is then possible to determine the true “economic” value of your business.

I have used the term “economic” several times. I do so with a reason: The value of your company is multi-leveled. The base value, the “economic” value, is driven purely on your recast financials that are used as your starting point for a 5-year pro forma (financial forecast). It does not take into consideration any premiums over this value that specific buyers may find in your business.

And this is an important distinction to keep in mind. Your “economic” valuation is determined using a combination of methods, some of which may include (depending on your industry and other factors):

• Prior Transactions – the valuations of deals that have been completed in your industry that are similar to yours can be used as a guide for your valuation.
• Public Comparables – publically held companies that are likewise in your industry that are also similar can be used after a public-to-private valuation discount is applied to their valuation.
• Industry Rules of Thumb – these are less scientific but can also provide a rough framework as long as you are using post-recast financials as your guide. There can be dozens of these in some industries so you have to pick the ones you use wisely.
• Discounted Cash Flow – this method takes your projected earnings for the 5-year pro forma and “discounts” them back to today’s dollars using a discount rate based on risk factors associated with your company.

These are just a few methods. In reality, your M&A advisor should use a combination of all of these when analyzing your valuation. One method is usually determined to be the best fit for your company based on extensive analysis and testing. So that is how your “economic” value is determined. It forms the baseline when selling a business.

The Market Value Approach

As you can see, the “economic” value makes no assumptions regarding who the specific buyer will be. Nor should it – it is purely based on your recast financials and valuation methodologies.

Ultimately the true value of your company will be based on this: What a willing and informed buyer will pay based on the value they place on the “intangibles" of your business. This is also known as the “market” value. And the reason this cannot be factored into your “economic” valuation is that the value of your intangibles will vary from buyer to buyer.

For example, Buyer A may find your blue chip customer base to be the intangible that really interests him. Or Buyer B might see tremendous value in your core base of very experienced employees. Other buyers may place value on your location, equipment, facilities, and brand name. As you can see, your ultimate value will be determined by what your buyer sees as valuable about your business.

And this is what makes ballparking a value at the outset of any process you begin with an M&A advisory firm so impossible. Until a thorough evaluation is done to vet the “economic” value and until a deal making team flushes out the intangibles and markets them to a wide range of buyers, there is no way to determine a company’s true value in an initial meeting. Any firm that claims they can do so should be avoided.

Since we are limited by space here to fully explore this vital topic further, I recommend if you are interested in learning more about selling a business, that you set aside time to attend one of our M&A seminars. These are no-obligation, complimentary sessions that explore in far greater detail the methods used to determine a business’ worth prior to selling a business. .

Takeaway

No matter what, don’t approach the valuation of your company lightly. It is a highly complex process and needs to be done accurately in order for you to truly be able to find the optimal buyer for your company.

The evaluation stage is critical when selling a business. Be sure to get it right before you start the process.

Carl Doerksen is the Director of Corporate Development at Generational Equity.

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